Next story:

editorial

EDITORIAL

Beware hidden costs of upfront fee in liquor deal

Gov. Paul LePage addresses members of the media and the public at Roopers Beverage and Redemption on Main Street in Auburn on Friday about his plan to use the revenue from the state's liquor business to pay back $484 million the state owes to 39 Maine hospitals.

Posted March 29, 2013, at 4:55 p.m.

After all the debate about competing bills that would structure the way the state awards its next liquor contract, a state legislative committee appears to be taking charge.

It’s good that the Veterans and Legal Affairs Committee plans to combine the best components of proposals from Gov. Paul LePage and Senate Majority Leader Seth Goodall, D-Richmond. Agreeing on what the best components are will be the tricky part.

It’s encouraging that committee members have homed in on one big difference between the two bills: the cost to borrow. Both plans would essentially borrow money to pay back hospital debt, but a provision in Goodall’s bill could make the borrowing costs more expensive for the state in the long run if the committee doesn’t do its research.

Both bills would dedicate revenue from the state’s liquor business to pay hospitals overdue Medicaid reimbursements, but they differ in the payment approach. LePage’s bill, LD 239, would use liquor sales proceeds to repay a revenue bond that would clear the hospital debt; the leftover money would fund transportation projects and drinking water and wastewater treatment systems, and the state’s rainy day fund.

Goodall’s bill, LD 644, would require the successful company to pay the state either $20 million or $200 million upfront at the start of the 10-year contract, plus a guaranteed fixed annual payment and a portion of the annual profits.

The potential $200 million upfront requirement should be a red flag for lawmakers.

That’s because it’s logical to assume the cost of the loan the company would have to take out to make the initial payment would be charged back against the liquor business. In other words, to pay the upfront sum, the contractor would likely pass on financing fees — interest, investor payback, lawyer fees — in the form of reduced profit-sharing with the state.

In 2004 the state leased its wholesale liquor business to Maine Beverage Co. in return for a $125 million upfront payment and an annual revenue share. Before agreeing to the $200 million payment provision in Goodall’s bill, the committee should find out how much Maine Beverage will have paid in debt service and management fees over the life of its 10-year contract, which expires in 2014, to make that initial upfront payment.

We suspect the costs of capital — then and in the future — would exceed the costs associated with a revenue bond. Say the state borrows money at, for example, 5- or 6-percent interest on a revenue bond (the state recently authorized borrowing based on a 4.5 percent interest rate on a 10-year bond). What private equity investor would lend $200 million and expect only a 5- or 6-percent return?

Clearly the cost of borrowing will depend on the successful vendor, how a deal is structured and the length of the contract. But a company usually has a minimum return it must earn on an asset to satisfy the people providing it with capital, or else they will invest their money elsewhere. A 5- or 6-percent return would barely cover what investors would have to pay in taxes on their new income.

Those in favor of requiring the $200 million upfront payment say it removes the risk of borrowing from the state and places it on the back of a private-equity firm. While there is always some risk in borrowing, Maine Beverage’s gross profit has only increased over time; and the state retains control of liquor pricing if revenues do start to dip.

Committee members have the power to ensure that future liquor revenue doesn’t pad the pockets of wealthy venture capitalists any more than it has to. It shouldn’t be a problem for the potential bidders to secure $200 million in capital because the liquor business offers a secure revenue stream, so removing the requirement from the final committee bill would not be a matter of company preference. There’s a lot of money to be made by investors on this deal. The committee needs to make sure it’s delivering the most lucrative return not for banks but the people of Maine.